The Financial Times was pretty restrained compared to the norm, and the FT still highlighted that the November fall was “the largest drop since a 3 per cent fall in January.”

But the fall was actually a bit smaller than what I was expecting.

Valuation changes on their own knocked $30 billion or so off reserves (easy math—$1 trillion in euro, yen and similar assets, with an average fall of 3 percent in November).

It isn’t quite clear how China books mark-to-market changes in the value of its bond (and equity portfolio).

My rough estimate would suggest mark to market losses on China’s holdings of Treasuries and Agencies of about 1.5 percent, or $20 billion (Counting the agency portfolio and Belgian custodial book, per my usual adjustment). Bunds and OATs (French government bonds) also fell in value—but SAFE likely has a couple hundred billion in equities too, and their value rose. But it isn’t clear that all of China’s assets are marked to market monthly, so there is a bit of uncertainty here not just about the overall performance of the portfolio, but also how the portfolio’s value is reported.

Sum it all up and it is possible valuation knocked somewhere between $30 and $50 billion off China’s headline reserves.

Taiwan has an extremely large current account surplus. Over 14 percent of GDP in 2015, and over 10 percent of GDP since 2012. (See the WEO data or this chart). Relative to its GDP, Taiwan’s current account surplus is far bigger than China’s current account surplus is relative to its GDP.

Taiwan’s central bank clearly has been buying foreign currency in the foreign exchange market. The balance of payments data shows between $10 and $15 billion of purchases a year in recent years, and roughly $3 billion of purchases a quarter this year (data here).

And Taiwan’s government clearly has been encouraging private capital outflows—notably from the the life insurance industry—largely by loosening prudential regulation, and allowing the insurers to take more foreign currency risk. Private outflows help limit the need for central bank intervention to keep the currency down, but also require private institutional investors to take on ever more foreign currency risk.

Plus, Taiwan’s real effective exchange rate—using the BIS data—has depreciated significantly over the past ten-plus years, unlike China’s real effective exchange rate. The fact that a weaker real exchange rate has gone hand in hand with the rise in Taiwan’s surplus shouldn’t be a surprise, but there are still a surprising number of folks who believe that real exchange rates don’t matter for trade in an era of global supply chains. In Taiwan’s case, the correlation between a weaker currency and a bigger current account surplus is clear.

My preferred indicators of Chinese intervention are now available for October, and they send conflicting messages.

The changes in the balance sheet of the People’s Bank of China (PBOC) point to significant reserve sales (the data is reported in yuan, the key is the monthly change). PBOC balance sheet foreign reserves fell by around $40 billion, the broader category of foreign assets, which includes the PBOC’s “other foreign assets”—a category that includes the foreign exchange the banks are required to hold as part of their regulatory requirement to hold reserves at the central bank—fell by only a bit less. $40 billion a month is around $500 billion a year. China uniquely can afford to keep up that pace of sales for some time, but the draw on reserves would still be noticeable.

The foreign exchange settlement data for the banking system—a data series that includes the state banks, but historically has been dominated by the PBOC—shows only $10 billion in sales, excluding the banks sales for their own account, $11 billion if you adjust for forwards (Reuters reported the total including the banks activities for their own account, which raises sales to $15 billion). China can afford to sell $10 billion a month ($120 billion a year) for a really long time.

The solid green line in the graph below is foreign exchange settlement for clients, dashed green line includes an adjustment for the forward data, and the yellow line is the change in PBOC balance sheet reserves.*

As the chart illustrates, the PBOC balance sheet number points to a sustained increase in pressure over the last few months after a relatively calm second quarter. The PBOC balance sheet reserves data also corresponds the best with the balance of payments data, which showed large ($136 billion) reserve sales in the third quarter.

Conversely, the settlement data suggests nothing much has changed, and the PBOC remains in full control even as the pace of yuan depreciation against the dollar has picked up recently and the yuan is now hitting eight year lows versus the dollar (to be clear, the recent depreciation corresponds to the moves needed to keep the yuan stable against the basket at this summer’s level; the yuan is down roughly 10 percent against the basket and against the dollar since last August).

The global capital flows story these days is complex. I wanted to build on Landon Thomas’ article with a set of charts drawing out how I think large surpluses in Asia and Europe are now influencing the TIC data. Obviously, this is a more technical post.

Asia’s surplus is big. In dollar terms, the combined current account surplus of China, Japan, and the NIEs (South Korea, Taiwan, Hong Kong, and Singapore) is back at its pre-crisis levels. China’s surplus is a bit smaller in 2007, but Korea and Taiwan are clearly running bigger surpluses. Yet unlike in the past, very little of Asia’s surplus is going into a reserve buildup. China is obviously selling, and its selling overwhelms intermittent purchases by Korea (Korea sold in q1 2016, but bought in q3) and Taiwan. The outflow of savings from Asia is currently overwhelmingly a private flow.

That is a change. And frankly it makes the impact of Asia’s surplus on global markets harder to trace. The Bank for International Settlement (BIS) data shows that much (I would say most) of the “capital outflow” from China over the last four quarters has actually gone to paying down China’s external bank debt, not to build up assets. It thus just becomes a new source of liquidity for the global banking system (once a dollar loan is repaid, the bank is left with a dollar—which has to be parked somewhere else).

And of course the eurozone and northern Europe also run substantial surpluses. Negative rates and ECB asset purchases in effect work to push investors out of super low-yielding assets in Europe, and into somewhat higher yielding assets outside the eurozone.*

The combined surplus of China, Japan, the NIEs, the eurozone, Sweden, Denmark, and Switzerland was close to $1.2 trillion in 2015. That is a big sum; one that has to leave traces in the global flow data. The U.S. current account deficit isn’t as big as it was prior to the crisis (and it is smaller than the UK’s current account deficit), but it is still financed, in part, by inflows from abroad into the U.S. bond market.

Total inflows from private purchases of U.S. bonds by foreign investors—together with the inflow from American investors selling their existing stock of bonds abroad and bringing the funds home—actually look to be at a record high in the TIC data (in dollar terms, not when scaled to U.S. GDP). $500 billion in inflows from foreign purchases of Treasuries, Agencies, and corporate bonds by private investors abroad, and $250 billion in financing from Americans bringing funds previously invested in foreign bonds home.

In earlierposts, Emma Smith and I added up central bank purchases of G-4 government bonds. This includes emerging market, Japanese and Swiss purchases for reserve accumulation and purchases by the Fed, Bank of Japan, European Central Bank and Bank of England during periods of quantitative easing (QE).

In this post we compare our estimates of official demand for U.S., Japanese and European bonds with changes in the supply of safe assets—that is, purchases by central banks relative to net new issuance of government bonds.

If central bank demand for a particular asset is lower than net new issuance, then private sector holdings of government bonds continue to grow but at a slower pace than would otherwise be the case. And if central bank demand for a particular asset exceeds net supply, then private sector investors—such as banks and pension funds—have to reduce their holdings of safe assets, and move into alternative assets.

This is how the portfolio re-balancing transmission channel of asset purchases works: private investors sell to the central bank and are forced to find new places to park their money. Conceptually, it should not matter much if the central bank buying say U.S. assets is the People’s Bank of China or the Fed, at least so long as both are expected to hold on to their purchases for a long-time. When either buys, it reduces the stock of assets in private hands and forces investors to shift into other assets.

Central bank asset purchases aren’t limited to government bonds of course, but, to simplify things, we limited our analysis to new issuance of government bonds. We know this over-simplifies. For example, a lot of “official” demand has gone into Agencies. Before the global crisis Agencies were a favorite of reserve managers globally. But adding in the Agencies to net supply takes a bit (ok, a lot) more work. The Fed also bought Agencies, but Fed holdings of Agencies and Treasuries are reported separately on their balance sheet. The numbers below only count the Fed’s Treasury portfolio.

In the U.S., the supply of Treasuries has exceeded central bank demand since 2010. This is largely because the U.S. Treasury ramped up issuance of Treasury securities after the crisis (offsetting, it should be noted, a big fall in private bond issuance). Even as annual net issuance of Treasuries slowed from its peak of around $1.7 trillion to a little over $600 billion, it has remained above official purchases. Right now there isn’t any official bid for U.S. bonds. Reserve managers on net have been selling and the Fed hasn’t been buying.

In an earlier post, I added reserve purchases by the world’s major emerging market central banks, Japan and Switzerland to the bonds purchases by the Fed, the BoJ, the ECB and Bank of England. I wanted to highlight that the central banks of the world were buying a lot of U.S. and European bonds before the big central banks started quantitative easing (QE). China and others bought a ton of bonds prior to the global crisis.

Emma Smith, an analyst at the Council on Foreign Relations, helped me with the data work for that post; she and I are jointly writing the follow up posts.

In addition to looking at the total number of G-4 bonds bought by the world’s central banks—counting bonds bought in large scale asset purchase programs (QE) alongside estimated reserve purchases—it is interesting to look at central bank purchases by currency. QE results in the purchase of your own country’s bonds; reserve purchases mean you need to invest in bonds issued by someone else—e.g. both the Fed and the PBOC have bought large quantities of U.S. Treasuries and Agencies at different times over the last fifteen years.

Take central bank purchases of dollar bonds. The chart below relies on the Fed’s data on its purchases, and an estimate of the dollar bond purchases implied by global reserve growth.

Before the global crisis, central bank purchases of dollar bonds came from reserve managers. Their accumulation of dollar assets picked up from around 2003—coinciding with the dollar’s depreciation against the euro, the beginning of the rise in China’s current account surplus and a pickup in capital flows to a range of emerging economies. In early 2008, the Fed was actually selling a portion of its bond portfolio—it didn’t want its balance sheet to expand as its lending to the world’s banks rose in the run-up to the global crisis—and after Lehman, reserve managers started to sell. But the Fed soon reversed course, and started purchasing large amounts of Treasuries and Agencies in its QE programs. And emerging economies recovered and resumed large scale intervention of their own—albeit at a lower level than pre-crisis—taking central bank demand to new highs.

Folks in the market like to talk about what is happening to China’s forward book. Some think that China (or its state banks) sold dollars forward last fall, and, well, to many the (modest) disclosed short position that China reports in the IMF’s SDDS reserves template isn’t all that convincing. In part because the disclosed forward book never changes much.*

But China also quite clearly isn’t the only country in Asia with a forward book. “Shadow intervention” is actually rather common, in both directions.

At the end of August, Korea had bought about $48 billion in dollars forward, up from just under $45 billion in July.** Technically, the forward book may be the forward leg of a swap contract.*** No matter—the rise in the forward book clearly reflects the central bank’s activities in the market.

Adding in the forward book shows the true scale of Korea’s intervention in August. The balance of payments reserve outflow was just over $3 billion. The balance of payments number should track valuation-adjusted headline reserves. The forward book rose by a bit more $3.1 billion.

I like to watch government deposits and government bond purchases too; they are up $1.7 billion (with a big increase in government deposits abroad). Korea’s intervention hasn’t always only appeared on the central banks’ balance sheet (though some of the portfolio debt comes from Korea’s National Pension Service). Sum it up, and Korea’s government could have bought as much as $8 billion in the market in August.

The proxies that provide the best estimates of China’s actual intervention in the foreign currency market in August are out, and they in no way hint at the stress that emerged in Hong Kong’s interbank market in September.

The PBOC’s balance sheet shows foreign currency sales of between $25 and $30 billion (depending on whether you use the number for foreign currency reserves or for foreign assets). A decent sum, but also a sum that is consistent with the pace of sales in July.

SAFE’s data on foreign exchange settlement, which in my view is the single best indicator of true intervention even though (or in part because) it aggregates the activities of the PBOC and the state banks, actually indicates a fall-off in pressure in August. The FX settlement suggests sales of around $5 billion in August. Even after adjusting for reported changes in forwards (the dashed line above).

All this said, there is no doubt something changed in September. The cost of borrowing yuan offshore spiked even though the exchange rate has been quite stable against the dollar and generally stable against the CFETS basket.

Just before the global financial crisis, I wrote a paper on the geostrategic implications of the United States’ growing external debt—and specifically about the fact that the U.S.’s main external creditors were increasingly the reserve managers of other states, not private investors. Yes, there were large two-way gross private flows in the run up to the crisis; think U.S. money market funds lending to the offshore arms of European banks who in turn bought longer-term U.S. securities. But, on net, the inflows needed to sustain the United States’ external deficit from 2003 on mostly came from the world’s big holders of reserves and oil exporters who stashed funds away in sovereign wealth funds.

With hindsight, I, and the others who speculated about how China’s Treasury holdings might be used for political leverage over-egged the pudding, as Dan Drezner, among others, has pointed out.

Greece’s indebtedness to private bond holders and banks proved a bigger constraint on its economic sovereignty than the debt the United States owes to the PBOC and other official investors. Germany was the creditor country that ended up with the leverage, not China.

And thinking back even further, Britain’s geostrategic vulnerability to the withdrawal of U.S. financing in the Suez crisis derived from its commitment to maintaining the pound’s external value. Letting the pound float was inconceivable at the time.

That as much as anything gave the U.S. leverage over Britain. Worth remembering.

I could argue that the global crisis reduced the United States’ need for all kinds of external financing significantly, which is true—and that the leverage that comes from the perception that China could rattle markets in times of stress has not entirely gone away.

I got my start, so to speak, tracking global reserve growth and then trying to map global reserve flows to the TIC data. So I have long thought that large scale central bank purchases of U.S. Treasuries and Agencies, and German bunds, and JGBs didn’t start with large scale asset purchase programs (the academic name for “QE”) by the Fed, the ECB and the BoJ.

Before the crisis, back in the days when China’s true intervention (counting the growth in its shadow reserves) topped $500 billion a year, many in the market (and Ben Bernanke, judging from this paper) believed that Chinese purchases were holding down U.S. yields, even if not all academics agreed. The argument was that Chinese purchases of Treasuries and Agencies reduced the supply of these assets in private hands, and in the process reduced the term/risk premia on these bonds. Bernanke, Bertaut, Pounder DeMarco, and Kamin wrote:

“…observers have come to attribute at least part of the weakness of long-term bond yields to heavy purchases of securities by emerging market economies running current account surpluses, particularly emerging Asia and the oil exporters …. acquisitions of U.S. Treasuries and Agencies took these assets off the market, creating a notional scarcity that boosted their price and reduced their yield. Because [such] investments were for purposes of reserve accumulation and guided by considerations of safety and liquidity, those countries continued to concentrate their holdings in Treasuries and Agencies even as the yields on those securities declined. However, other investors were now induced to demand more of assets considered substitutable with Treasuries and Agencies, putting downward pressure on interest rates on these private assets as well.”

I always thought the mechanics for how the Fed’s QE impacts the U.S. economy—setting aside the signaling aspect*—should be fairly similar. Both reserve purchases and QE salt “safe assets” away on central banks’ balance sheets.**

There are now a number of charts illustrating how the ECB and BoJ have kept central bank bond purchases high globally even after the Fed finished tapering. Emma Smith of the Council’s Geoeconomics Center and I thought it would be interesting to add reserve purchases to these charts and to look at total purchases of U.S., European, Japanese and British assets by the world’s central banks over the last fifteen years—adding the emerging market (and Japanese and Swiss) purchases of G-4 bonds for their reserves to the bonds that the Fed, the ECB, the Bank of Japan and the Bank of England bought.

Obviously there are important differences between balance sheet expansion done through the purchase of foreign assets (reserve buildup) and balance sheet expansion done though the purchase of domestic assets (quantitative easing). One is aimed at the exchange rate, the other at the domestic economy. But if portfolio balance theories are right, the direct impact on bond prices from foreign central bank purchases of bonds and from domestic central bank purchases of bonds should I think be at least somewhat similar.

New Independent Task Force Reports

India now matters to U.S. interests in virtually every dimension. This Independent Task Force report assesses the current situation in India and the U.S.-India relationship, and suggests a new model for partnership with a rising India.

Rates of heart disease, cancer, diabetes, and other noncommunicable diseases (NCDs) in low- and middle-income countries are increasing faster than in wealthier countries. The report outlines a plan for collective action on this growing epidemic.

The authors argue that the United States has responded inadequately to the rise of Chinese power and recommend placing less strategic emphasis on the goal of integrating China into the international system and more on balancing China's rise.

Campbell evaluates the implications of the Boko Haram insurgency and recommends that the United States support Nigerian efforts to address the drivers of Boko Haram, such as poverty and corruption, and to foster stronger ties with Nigerian civil society.